ETF Update: Can Banks Benefit from Financial Regulation?

(I delayed this article from my regular Sunday posting time since there was so much volatility, perhaps generating misleading signals.  The ratings have been updated to reflect the current situation and do not include the customary one-day lag).

It now seems clear that new financial regulations will soon become law.  Can banks benefit from this development?

Background

Traders all seek rewards but they have differing appetites for risk.  It is important to find a method that suits your personality and needs.  Our trading systems are basically Trend-following, but also include recognition of Cycles and a touch of Anticipation.  Since we apply the method to ETFs, we call it the TCA-ETF system.  We follow two versions of this method, designed for two clients with different needs and risk appetite.  [New readers can find more information about the models at the end of this article.]

Let me discuss this week's featured sector before turning to our own ratings.

Spotlight on the Banks

We trade banks via the SPDR KBW Bank ETF (KBE).  The ETF tracks the KBW Bank Index.  It has very good diversification -- 25 holdings with most in the 4% to 6% range.  A few large banks are higher, but no single holding is over 9%  The forward P/E ratio is over 17 and the trailing is over 20, but the price to book is only 1.01.  The dividend yield is under one percent.  Here is the chart:

Fundamental Analysis

Some of the news for the sector relates to the financial reform bill.  ETF Daily News opined that changes in the bill were favorable to banks.

There is a consensus that the regulations are more significant for large banks.  Even those institutions may have pricing that reflects the pending legislation.  GOP changes have relaxed some concerns raised by the banks, especially those related to cost-cutting as a function of size.

Tom Lydon reached a similar conclusion,  citing a MarketWatch column assessing the regulatory impact.

In my weekly market column I expressed caution about banks because of possible European exposure.  Any improvement in Europe is a positive for financial stocks, so the weekend news was bullish.

Other ETF Experts

We always monitor the conclusions of other ETF experts when considering a trading position.  This week none of our sources cited the group on technical grounds.  (It is important to note the absence of support for a position).  It is fair to say that this group is "unloved."

Weekly TCA-ETF Rankings

We are currently fully invested in our ETF programs,  but there are only a few remaining candidates in the "buy" range.  We are happy to report and discuss performance with interested investors.  We also offer a report on how we use the models, and a free weekly email update.  (Write to etf at newarc dot com).  Our actual trading is a combination of both models and some weekly timing.

We usually publish the ratings list as of Thursday's close in our weekend update, a one-day delay.  Given the wild market gyrations from the last few days, I felt that the Thursday ratings would be unhelpful and perhaps even misleading.  Instead, I delayed the article for a day.  I am also including today's current ratings.

Please note that we are not recommending these sectors, since investor needs and risk tolerance varies.  We hope everyone finds the ratings to be a useful supplement to their own work.  The recommendations can change quite rapidly in this environment.  I would not be surprised to see every sector in the penalty box in a few days.

Here are the current rankings for both Oscar and Felix.  It is interesting to note that Oscar is even more negative than Felix.  While we are mostly following Felix, fans of Oscar should note that the inverse ETFs have positive ratings.

  

Note for New Readers

Our weekly ETF Update is designed to assist both investors and traders interested in ETF's and Sector Rotation.  We also have free reports, available upon request to etf at newarc dot com.  These reports describe how we use the system, compare results from Oscar and Felix, and contrast the method with our long-term trading approach.

Our Method.  In this past article, we described our basic methodology and why we believe the rankings are useful for fundamental traders and technical traders alike.  While we urge readers to check out the entire article, the key point is that ETF's pose challenges and opportunities different from investment in individual stocks.  The fundamentals may be more difficult to assess.  Even with a good grasp on fundamental trends, there is a lot of technically-based trading in ETF's.  This means that those trading with a fundamental approach (and we do this as well) want to monitor the "hot money" moves.  Here is an article on that point.

The system synopsis. We look at Trending sectors, Cyclical Sectors, and build in an element of Anticipation for both entry and exit -- thus the name of the model, TCA-ETF.  While we do not reveal the exact methodology for spotting trends and cycles, the system is not a "black box."  The basic elements are used by many, and widely reported.  We even discuss the need for human analysis as opposed to black box trading.

We report the rankings each week, now on the weekend with a one-day delay, using the Thursday output from the model.  We monitor and trade this daily, and offer a free report (request via the email address on the top left of the site) for those interested in our weekly trading program.

Oscar and Felix. We follow two versions of this method, designed for two clients with different needs.

• Oscar believes in the long-term strength of the economy and the stock market.  He has a lovable and irrepressible enthusiasm.  When things go wrong, he steps back for a bit, but soon tries again.  He expects to do better than others during good times.  Oscar understands that this approach involves more risk.  Oscar is opportunistic.

• Felix also has a positive long-term outlook, but he is something of a fussbudget.  He is much more cautious, with an emphasis on capital preservation.  He is perfectly willing to step aside from the market when there are signs of danger.  He knows that he will miss some moves, but that is OK.  He scores big gains when the market moves lower and he escapes the loss.

There is more detail on Oscar and Felix in this article.  There is more about the Penalty Box here.